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China Fire & Security Group, Inc. (NASDAQ:CFSG)

Q4 2006 Earnings Call

March 29, 2007 4:30 pm ET

Executives

Chris Donnelly - IR, HC International

Brian Lin - CEO

Analysts

William Raleigh - Wainwright

Albert Lee - Maxim Group

Wei Li - Whitebox Advisors

Michael Rosenthal - QVT Financial

Jay Lu - Susquehanna Financial

Art Tanjung - Catera

Presentation

Operator

Good afternoon. My name is Larry and I will be your conference operator today. At this time, I would like to welcome everyone to the China Fire & Security Group Incorporated Fourth Quarter and Year-end 2006 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. (Operator Instructions). Thank you.

It’s now my pleasure to turn the floor over to your host, Mr. Chris Donnelly of HC International. Sir, you may begin your conference.

Chris Donnelly

Thank you, and welcome everyone to the China Fire & Security Group's first ever quarterly conference call. The fourth quarter and full year press release was just released to the wire.

On our call today is Mr. Brian Lin, Chief Executive Officer of China Fire & Security Group.

Before we get started, I am going to read a disclaimer about forward-looking statements. The conference call may contain in addition to historical information, forward-looking statements within the meaning of the Federal Securities laws regarding China Fire.

Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements, other than statements that are historical in nature.

These forward-looking statements are based on current management's expectations and are subject to risks and uncertainties. That may result in expectations not being realized and may cause actual outcomes to differ materially from expectations reflecting these forward-looking statements.

Potential risks and uncertainties include product and service demand acceptance, changes in technology or economic conditions, the impact of competition and pricing, the impact of government regulation, and other risks contained in the statements filed from time-to-time with the SEC.

All such forward-looking statements, whether written or oral and whether made by or on behalf of the company, are expressly qualified by the cautionary statements. Because forward-looking statements are subject to risks and uncertainties, we caution you not to place undue reliance on these statements.

Forward-looking statements made during this conference call speak only to the date and/or oral and written forward-looking statements and are qualified by these cautionary statements.

With that out of the way, I would now like to turn the call over to Mr. Brian Lin. Brian.

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Brian Lin

Yes. Thanks Chris and thank you everyone for joining us today. For the new investors on the call today, I would like to provide a brief introduction of the company, and then provide a recap of our fourth quarter and 2006 full year results. After that, I will open the call up for questions.

China Fire & Security was founded in 1995 in the People's Republic of China. Over the years and through several small acquisitions, the company has become the largest manufacturer, distributor and installer of industrial fire protection product and services in China. Its revenue is derived from the combination of product sales, design, installation and maintenance services.

In 2006, the company recorded over $32.5 million in revenues and over $9.2 million in pro forma net income. Our product offering includes fire detection, fire control and fire extinguishers for industrial customers operating in the iron and steel, power and petrochemical industries.

In addition to product sales, we also provide customers with the initial design of the systems, installation and maintenance. This is an important point, as we are the first company in China to leverage high technology of fire protection and safety products to premier industrial clients, while providing an end-to-end turnkey solution.

Our products are sold under the Sureland’s brand name and are well recognized in Chinese markets.

Let me take a few minutes to elaborate as to why our products and services are differentiated in the market. First, our product line addresses all aspects of industrial fire safety from fire detection to fire system control and to extinguishing, providing customers with the broadest product suite in the market.

China Fire has secured numerous major industry honors, including number one in the category of System Contracting Enterprises. We are also being ranked highly among the top 30 companies in Fire Protection Industry by the China Fire Protection Association.

And secondly, we have an extremely strong research and development capability. Our R&D team includes a staff of 30, the majority of which graduate from top universities, including one PhD from Qinghua University.

Additionally, we also partner with several other research institutes and universities and we jointly develop products for certain consumer applications.

Also as part of our team, we have a technical consultant, who was a former Chief of the Fire Protection Bureau in China, and he advises product development.

Our focus on R&D gives us an edge in the market, as evidenced by our 39 issued patents, covering fire protection, systems control and fire extinguishing, and the addition of three patents, plus two pending.

Our low-cost high capacity manufacturing base; we currently have two operations in Beijing. We have a 30,000 square feet facility that we just recently acquired, a second facility just outside of Beijing, which is in Shenzhen city to accommodate future growth.

Thirdly, we have a new production capacity of a 20 million space of linear heat detectors. Combined, all the facilities are approximately 50% utilized with ample room to accommodate future growth.

We will look to leverage our strong R&D efforts and market expertise to further expand our proprietary product offerings and further utilize our facility. To complement this expansion, we are also exploring relationships with several international manufacturers, who potentially act as an OEM manufacturer for their products. We expect over the next year to announce several new partnerships.

Fourth, we are one of the only domestic Chinese company in the market who has a nationwide sales network. We have established nearly 20 branches and offices throughout the country to facilitate the sales.

Additionally, China Fire has excellent relationship with outside distributors and resellers who augment our internal sales force. These sales force efforts have allowed us to penetrate an expansive customer base spread 20 provinces into China.

Finally, our management team is experienced and possesses significant industry knowledge. Mr. Gangjin Li is the Chairman of the Board. Mr. Li founded the company in 1995 and is responsible for much of the strategic planning, sales and marketing. He has over 12 years of experience in the fire protection industry in China and is a critical component to our success.

As mentioned by Chris already, I am the CEO and I have over 17 years of management experience in both US and in China. I too was an initial investor in China Fire before taking the role as CEO.

Prior to China Fire, I was the CEO and Co-Founder of Beijing Linkhead Technologies, which was sold to PacificNet, another NASDAQ listed company under the symbol PACT in 2003.

Additionally, we have many talented employees in the company in the areas of accounting, finance and sales and support. The breadth and scope of our team we feel is excellent and unmatched by our domestic competitors.

Let me take a few minutes to discuss the market for fire protection products in China. First, it is important to note that the market for fire protection still is in its infancy. China's industrialization is still in its early stages with many manufacturers lacking even the most basic fire protection systems.

It is estimated that 80% of industrial plants are not compliant with current government fire safety requirements. Despite the low level of compliance, the market for fire prevention as a revenue in the PRC exceeded over $3.7 billion in 2005. The industrial sector is estimated to be around $900 million according to a document produced by the Beijing Chemical and Electrical Engineering Association in 2004.

Driven by increasing government regulations, the industry is expected to grow at more than 11% annually for the next five years. Basically, the Fire Service Law enacted in 1998 and Safe Production Law enacted in 2002 is beginning to provide rules and regulations regarding compliance, while setting the stage of penalties for companies that do not meet the established requirements.

Currently, if there is an accident at a major factory, the plant manager will now be held accountable for non-compliance. Often times, this may mean loss of job for key employees. What we are finding is an increasing number of key decision makers recognizing the need for fire safety and making the decision to become compliant.

We expect over time and as rules and regulations become clearer, the government will begin to levy heavy penalties to the companies for non-compliance.

Additionally, fire protection is not currently required for insurance purposes, but we believe as the market becomes more mature, at least will also change. The combination of these factors, we believe, we will hold positive implications for future market growth.

It is important to note that despite being the largest domestic manufacturer and provider of fire solutions in China in the industrial fire protection industry, we hold less than 3% of the total market share.

We believe that we are well positioned to benefit from the increased secular trend towards greater fire protection, while gaining additional market share leading to higher revenues.

While the market is growing and beginning to attract significant attention, there are numerous barriers to entry to limit competition. First, industrial fire safety system demand a greater degree of technical specialization as compared to residential and commercial construction, creating a unique niche for China Fire.

Secondly, comprehensive fire solutions are complex and require significant expertise in both manufacturing and installation and design. China Fire Solutions are specialized and tailored to address these complexities.

Third, as mentioned, our end-to-end turnkey solution allows us to provide each vertical component that the customer requires. It is also important to note that fire protection installations are sometimes down over multiple projects. And also for extended period of time once we begin a project with the customer. It is very difficult for our company to be displaced.

As far as our revenue competition, we derive sales from three major sources. These are global solutions, which made up approximately 74% of our 2006 revenues. Product sales accounted for 23% and maintenance services of 3%. This should begin to have a positive impact on the overall margins.

Currently, total solution generates about 48% gross margins with product sales carrying 53% and maintenance of 65%. But it’s important to note that maintenance services should begin to increase as a percentage of revenue going forward based on our installed base of business.

We are fortunate to have an established base of very reasonable customers that provide us with recurring revenue opportunities. Our top customers for 2006 include: Ma An Shan Iron and Steel, Wuhan Iron and Steel, [Tianjin] Iron and Steel, Anshan Iron and Steel and China Three Gorges Project. These five clients have contributed about $9.1 million in revenue, which is approximately 28% of the total revenue.

Now that I have provided an introduction to our business, I would like to give investors a snapshot of our capital structure and timeline of events leading up till today.

China Fire became listed in the US through a reverse merger in October 2006. Simultaneous with the reverse merger, we engaged in the first of two planned private placement with credit institutional investors. These two types were essentially the same deal, with the first one taking place on October 27 and the second on December 5, 2006.

In aggregate, we raised a total of $7.1 million in net proceeds. Included in the placement were $1.2 million warrants with an average stock price of approximately $4.08. These warrants are callable under certain provision.

I would also like to add that our registration statement was effective on December 29, 2006. As of the close of the transaction, we have a total of approximately 28 million fully diluted shares. Management owns approximately 52%, with balance held by other affiliate parties and the institutional shareholders.

On February 9, 2007, we changed our symbol from UPFS on OTCBB to CFSG. We are currently looking to make a move to a major exchange. I believe we will meet many of the requirements. We look to have new information on this over the next six to eight months.

With that out of the way, let me turn to our financial results for both the fourth quarter and the full year 2006. The fourth quarter and the year-end results represent a continuation of a positive momentum that we have established over the last couple of years.

Our fourth quarter revenue increased 50.5% to $8.9 million as we continue to improve sales execution across our customer base. Plus, our gross profit was $4.1 million for the quarter, an increase of 29.1% year-over-year. Gross margins for the quarter were 46.1% as compared to 53.7% last year.

Gross margins were impacted by a greater percentage of revenues from third-party products, which carry a lower gross margin as compared to the fourth quarter of last year.

Operating income increased 29.6% from the same period last year, with respective operating margins of 12.7% and 16.1%.

During the fourth quarter, we reported a net loss of $0.4 million as a result of non-cash charges of $1.7 million. $1.6 million of these charges were related to change in fair value of derivatives and additional $0.1 million associated with management stock option plan.

Excluding those non-cash charges, pro forma net income was $1.3 million for the fourth quarter of 2006 or $0.05 per weighted average fully diluted share.

Let me briefly review full year 2006 results. The revenue for 2006 increased 53.2% to $32.5 million compared to $21.2 million in 2005. Again, our business continued to benefit from a favorable trend across China for greater fire protection and increased customer wins and penetration.

Gross profit increased 29.5% to $16.2 million as compared to $12.5 million in 2005, with gross margins of 50% compared to 59.2% in 2005. Operating expenses increased versus last year by 50.1% to $8.3 million compared to $5.5 million.

We increased our SG&A expenses to support our sales efforts, but we also incurred a $600,000 one-time expenses related to management stock option plan.

Going forward, we expect to incur fairly small non-cash expenses related to stock option plan.

Income from operations was $8 million for 2006, an increase of 13.3% compared to $7 million in 2005 with operating margins of 25% and 33.2% respectively.

Net income on a GAAP basis was $7.0 million, representing a slight decrease when compared to $7.3 million in 2005, which is as a result of the $2.2 million increase in total non-cash expenses.

So, our pro forma net income excluding those non-cash charges was $9.2 million, which increased 26.3% versus the comparable period last year with non-GAAP weighted average fully diluted share of $0.38.

GAAP earnings per weighted average diluted share were $0.29 for 2006 as compared to $0.30 last year.

As a result of positive cash flow from operations and a $7.1 million in net proceeds from our capital raised, we are in very strong financial position with $9.4 million in total cash.

Current assets increased 102.1% to $43.7 million versus last year with the company reporting working capital of $23 million on December 31, 2006. Total assets at year end were $48.3 million, representing an 87% increase year-over-year. We have no long-term debt, and have a shareholders' equity of $25 million.

We are very pleased with our results and believe that we are well positioned to continue to grow the business based on a number of key factors. We look to gain additional market share in our core industries of iron and steel production, power and petrochemical plants. We're beginning to leverage our brand name and recognition throughout China to capture new business in the industries like transportation systems, nuclear energy, large space, open market areas, such as stadiums and theaters.

Further, we look to expand our proprietary product offerings to increase gross margins, while taking advantage of our ability to expand manufacturing capacity.

We believe we will also have the ability to act as an OEM distributor and as an OEM manufacturer for an established international player.

Finally, we will selectively target acquisition with strong product lines and engineering capabilities in regional market that will bolster our current product offering, while further catering to our large and installed customer base.

In summary, the prospect for the company remains bright and the entire management is dedicated to maximizing shareholder value. At this point, we are committed to achieving our major target for 2007 of $13 million in cash, net income which represents a $0.46 in fully diluted earnings per share on the cash basis.

I would now like to turn the call over for questions. Larry?

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from [William Raleigh of Wayne Wright].

William Raleigh - Wayne Wright

Good afternoon. I was wondering if you could discuss the backlog year-over-year. I know you don't like to talk about it in the quarters, but how did it end up for the year and what I should see going forward?

Brian Lin

We have a very solid customer base. Our clients are typically large clients and our projects most often amounts to two years for a large project. So, with this, our nature of business when it comes to the total solutions, we will have a backlog in the company. So, for 2005 we have got a $24 million unrecognized revenue carried over to 2006. And in 2006, we’ve got $29 million unrecognized revenue carried over to 2007.

William Raleigh - Wayne Wright

Could you also talk about whether there are some projects in the new areas, the new industry sectors that you want to go forward in, such as transportation and tobacco and wine, and the other areas that you were looking forward to?

Brian Lin

Yeah. Maybe I can just use the example of a project in road tunnel. We signed a contract for $3.2 million. We leverage that for a fire protection system, total solution project for a road tunnel, which is across the Yangtze River. So, that's a great opportunity for us, because in the transportation industry the fire protection has really low fire specifications yet. And we have used our own research and development team to come out with this design, and so we won the project.

At the same time, we are also participating in the international testing joint efforts organized by National Research Centre of Canada, where we are actually participating in that to jointly find out what is the absolute solution. The participants in that joint testing are companies like Tyco, like Siemens, Omniware, etcetera. These are all multinational companies. But hopefully, with the joint testing, we would be able to see the fire specifications for China's testing industry.

William Raleigh - Wayne Wright

Alright. And just one last question. In the second half of the year, your gross margin was suppressed relative to the first. Do you see that coming back as soon as the first half of this year?

Brian Lin

Yeah, I think in this business, we as a general contractor have a very good client base. Sometimes our clients want us to do a little bit more. And they trust us and so we would sell to them not only our own products, but also source products from third parties to come out with a complete system. So, sometimes our margin gets depressed not because they are selling our own products cheaper, but there is a competition of the product that makes the gross margin look less.

However, there are good revenue and profit opportunities and we don't really to give up on those. And also with the trust from the clients, we think we can get better, like maintenance revenues, etcetera, from the clients.

In terms of the gross margins, I think we are comfortable with the numbers now and we think we should continue with the numbers we have.

William Raleigh - Wayne Wright

Thank you very much.

Brian Lin

Sure. Thank you.

Operator

Your next question comes from Albert Lee of Maxim Group.

Albert Lee - Maxim Group

Hey Brian, how are you doing? A question on numbers here again. Just a quick question on the gross margin again. Looking into this year or 2007, can you give us a sense as to what your achievable gross margin levels are and where you believe you need to get to in order to hit your $30 million to make a good target? And you think you can get back to the high 50% level?

Brian Lin

As I mentioned earlier, the gross margin is important from the company's perspective, but then we also look at the requirement from the clients. If they want us to include certain products that are not our own products, then we do like to accommodate those clients.

So, I think the gross margin of our own products still will be higher in the next year. But I don't want to promise that the overall gross margins would be growing much higher. But I think we are comfortable. The company is trying their level best to win projects with pretty good margins.

Albert Lee - Maxim Group

Okay. Great, thank you.

Brian Lin

Sure.

Operator

You next question comes from Wei Li with Whitebox Advisors.

Wei Li - Whitebox Advisors

Hi Brian how are doing?

Brian Lin

Good, how are you?

Wei Li - Whitebox Advisors

Good. I got two to three questions. One is that I do not quite get the backlog number. You mentioned $29 million unrecognized revenue. Should I take it as the backlog?

Brian Lin

Yes.

Wei Li - Whitebox Advisors

That would be the backlog number?

Brian Lin

That's the backlog number.

Wei Li - Whitebox Advisors

Okay. So if you have this backlog number, what's the gross margin right now if you look at this backlog? On the $29 million, what's the gross margin that you expect to make?

Brian Lin

I think it will be consistent with the numbers for 2006.

Wei Li - Whitebox Advisors

Considering with the number in 2006 full year or the Q4 one?

Brian Lin

Full year basis.

Wei Li - Whitebox Advisors

On a full year basis. Okay. Second question, you kind of implied that your client wants to ask you to do more, so that's why your gross margins come down. Will you see like increasing revenue going forward, because you cannot get the additional revenue that you were not expecting because your client asked you to do more?

Brian Lin

Yes. It's shown in our revenue growth. We are growing above 50% on top line and in the bottom-line we are growing approximately 30%, 26%, 27%. So, that shows you that we are getting larger projects as customers really trust us. We really want to leverage on that and make more money for the company.

Wei Li - Whitebox Advisors

Okay. Got it. My final question for you now. Are your warrants, the highest -- what's the price like you take your charges at right now? I just want to get a sense of how many charges do you have in the future?

Brian Lin

That's a good question. Whitebox, you guys are our investors. You hold the warrants, especially those warrants that are issued to the investors. And the provision where in the event of a merger of a similar organization or a company, the warrant holders can request to be paid in cash for their warrants based on their model.

So that ability we see cash, in circumstances where other shareholders will not necessarily receive cash, (inaudible). So that's why it is accounted as derivative instrument liabilities going forward and will be mark-to-market at the reporting date. So, to cut the long story short, this will be going on for the company. But we are working, we are talking with the investors, and now we are talking with you guys as well to probably pick out that clause. So that the warrants will be valued at one time and will be amortized over the term of warrants. That will be a lot easier for the company. So, we can’t really just focus on the companies for the operations and without worrying about the charges relate to the warrants while the stock price goes up.

Wei Li - Whitebox Advisors

Okay, good. All right, thank you, fair enough.

Brian Lin

Thank you

Operator

Your next question comes from Edward Hemmelgarn of Shaker Investments. Mr. Hemmelgarn, you may ask your question.

Your next question comes from Michael Rosenthal of QVT Financials.

Michael Rosenthal - QVT Financial

Hi, Brian.

Brian Lin

Hi, Mike.

Michael Rosenthal - QVT Financial

Can you give a little update on what's going on in the [Tianjin] plant and any transition that you are doing of manufacturing to that facility?

Brian Lin

Yes [Tianjin], that particular plant used to be stake-owned that went bankrupt. So, we together we have the local partner took a small equity position in the plant, hoping that we could leverage on that land to expand our manufacturing capacity. So, we are working very diligently to actually develop some new products in this facility. We will be actually probably set up a joint venture or things like that to further leverage to have a controlled ownership in the plant so that we can expand our product lines.

Another point is actually the [Tianjin] plant used to be very strong in the fire extinguishing product lines. And that is still the area that we are lacking. We are very strong in the larger base fire extinguishing systems and products. Although, there are also other fire extinguishing products which are complementary to our product lines like foam-based fire extinguishing systems or gas-based fire extinguishing systems. So those are the things that we will be looking into expanding.

Michael Rosenthal - QVT Financial

So mostly it’s sort of development work right now rather than a lot of product coming out of that right now?

Brian Lin

Yes, but we are not only just doing development, we are also working with people who has the right technologies and set up joint ventures. And hopefully, we can get to market much sooner. I think there is quite a large market for those kinds of fire extinguishing product as well. So, we are very excited about the changing opportunity.

Michael Rosenthal - QVT Financial

And I realize that you probably don't want to say anything too much, but are you currently still looking at opportunities to buy a new area of product base by acquiring other entities or merger --?

Brian Lin

Yes, as I mentioned earlier that we are only 3% of the industrial fire protection industry. So, there is lot of the opportunities there, and there are a lot of companies who have good products, extinguisher products. Sometimes, I think, we are actually looking, and I think we need to fit a lot of criteria, like for example the management team, the product that whether it is supplementary to our product line, whether we can leverage our sales force to sell the products, whether it can lead us to a new industry sectors. Those are a lot of things that we look at. And I think that to become the listed company we do have the resources and have access to capital. We should leverage on that.

Michael Rosenthal - QVT Financial

Thank you very much.

Brian Lin

Thank you, Michael.

Operator

Your next question comes from [Jay Lu] of Susquehanna Financial.

Jay Lu - Susquehanna Financial

Hi, good afternoon.

Brian Lin

Hi, Jay.

Jay Lu - Susquehanna Financial

I just have two quick questions, how much market share do you have right now in China?

Brian Lin

How many markets?

Jay Lu - Susquehanna Financial

Yeah, how much market share do you have right now?

Brian Lin

In the industrial fire protection industry we have about 3% of the market share. So, it's very small. That tells you that the market is very fragmented, a lot of regional players, a lot of small product manufacturers.

Jay Lu - Susquehanna Financial

Are there opportunities in the near future for your self?

Brian Lin

Yeah, of course. We think we have a very strong brand name in China and now we're close to being a US listed company, so we have very good credibility as we start looking with people and looking for partners to join our team.

Jay Lu - Susquehanna Financial

Okay. That's great thank you.

Operator

Your next question comes from Wei Li of Whitebox Advisors.

Wei Li - Whitebox Advisors

Hi, Brian. Sorry to beat a dead horse. On the margin side, just want to get a sense of how much markup did you put on the third party product you sell to the end customer?

Brian Lin

Between 20% to 30%. Sometimes in the competition we use that not really as the last leader, but we don't really markup too much because sometimes they are not really a large portion of our project. So, the courtesy to the client really is to markup a lot.

Wei Li - Whitebox Advisors

Okay, good. Do you disclose how many contracts or how many potential contracts you are talking at the end of '06 and what's your win rate? If you apply the win rate in the past, how much would that mean for your '07 revenue? I know that I am kind of pushing the envelope a little bit, but just wanted to get a little bit clarity?

Brian Lin

I think our sales team across the country has quite large pipelines, projects that they are following. Some are really huge projects. I think traditionally, we have been winning more than 50% in iron and steel industries and in other industries may be between 30% and 50%. So I don't have the exact numbers for the pipelines that the sales are attacking. But we're very comfortable that in the market the pipeline is quite promising and we should be able to secure most of the projects that we are following.

Wei Li - Whitebox Advisors

Okay, great. Final question, can you tell a little bit more about the linear heat detector, you mentioned last time that you guys probably made 80% gross margin on that and you are see a lot of hope with that product?

Brian Lin

Okay. The linear heat detector is one of our main products, which is really a world's leading product. The linear heat detector is technically like a wire type detector that can sense the temperature change or the rate of rise of the temperature, for example. So, it is widely used in all industrial environments, therefore protecting objects like power cables, like oil tanks, etcetera.

So, it is very widely used. And since June of 2006, we have helped the government to upgrade the product standards in China. So, now the standards in China is actually better or higher than the UL standard or the international standards. With that, we actually helped formulating the standards that we have applied for few patents around that also.

As of now, we are not only one, but we are the only one who has the technology to pass the certification in China. And none of the multinational companies' product has passed the certification in China today. So, we do see that there are tremendous opportunities for the linear heat detector in China in 2007, and we are also looking into international opportunities wherein countries like India and Southeast Asia is also going through the industrialization process. We are going to leverage our value-added resellers to go after those markets.

Wei Li - Whitebox Advisors

Alright. Thank you.

Brian Lin

Thank you, Wei.

Operator

Your next question comes from [Art Tanjung of Catera].

Brian Lin

Hi Art.

Art Tanjung - Catera

Hi, how are you? Couple of questions have been asked, but I have one clarification. On the heat detector, you mentioned that you have the better standards, and I guess your foreign competition cannot satisfy the standards currently. Can you help us put things in prospective in that? If somebody is installing linear heat detectors in a project, what are they using? Are they using sub-standard products or help us understand what they are using, if they are not using your products?

Brian Lin

Art, can you repeat your question? I think I got cut-off on the last thing. I didn't quite get the last part.

Art Tanjung - Catera

Sure. You mentioned your linear heat detectors are the one-off procedure that has passed the higher standards by the Chinese government. And I think you mentioned that two of your main competitors, which are foreign companies, their linear heat detectors do not satisfy the current requirements. So, if there is a project going on and if it's not your product that's being used, what are they using?

Brian Lin

Okay. With these new standards, theoretically, all the new projects needs to use the new products that meet the new standards. However, there are projects that are going on sometimes for two years and the project or the tender before the (inaudible), then they can still use the old standard product. It is going forward and they are not supposed to. But that's the situation in China. The law enforcement is not that strong. There are people out there that don't really put up a normal fire protection system before operating their plant.

So, these are issues that we are working very diligently with the fire bureaus in lot of different provinces. And in the projects that we tender, to make sure that everybody is following the country's standard.

It doesn't matter if it's new or old. With new standards out, then the old standard -- the old product certification expires. So, in a way, say today, if they are selling the product on a market then they are really against the law. Does that answer your question, Art?

Operator

(Operator Instructions). There appear to be no further questions. I will turn the floor back over to you, Mr. Lin.

Chris Donnelly

Thank you everyone for joining us today for the call. Please feel free to reach out to myself or Brian if you should have any further questions. Thank you.

Brian Lin

Thank you.

Operator

This concludes today's China Fire & Security Group Incorporated conference call. You may now disconnect.

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China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

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Source: China Fire & Security Q4 2006 Earnings Call Transcript
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